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The Earl of Longford: My Lords, perhaps I may ask the noble Lord for some information. When the auditors are at fault also, does that let out the Bank, or not?

Lord Hollick: The report points out that the auditors—there are two firms concerned in this case because this sorry tale happened over a three-year period—certainly missed some glaring holes in the control system of the Barings securities businesses. They too do not come out of this affair with any credit.

I find a curious difference between the behaviour of the Bank of England in the case of Barings and the regulatory regime that I have experienced in a number of institutions. I am puzzled, surprised and not a little saddened by the different treatment that appears to have been meted out. It comes back to the words "formality" and "informality". There is a great deal of play made in the document about informal systems, as the informal management systems at work in Barings. And there is an informal regulatory regime. That is not good enough. We need to have formal codification and formal reporting. We need to have a harder edged regime if it is to cope with the complexities of financial institutions and, in particular, with the new products which are coming along and which carry a whole series of risks, both individual and systemic, which are extremely difficult to understand.

Understanding is a key point. One of the newspapers referred to a generation gap. That is quite a problem in financial institutions. When one goes through the Treasury side of a banking institution as a trainee, sitting on a desk, one is in one's twenties. When one rises to the lofty heights of a director or chief executive, it is some 20 years later. That is some 20 years of financial innovation that have been missed out on. Probably one will never get one's mind round some of the new products, let alone understand the extent of the risks

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involved. So there is a real generational problem both with the institutions themselves and also, I submit, with the regulators.

Another problem which arose in the case of Barings was the issue of consolidation. "Solo consolidation" is the term that is used. It means that everything is bundled together, the security side and the banking side. In the case of Barings, we can see that that masked huge movements. In the space of some six weeks, £500 million was shipped out to the Singapore subsidiary. In a disaggregated world, if there were fire walls put up between the various businesses that would have been spotted. At the end of the day, all of these weird and wonderful instruments, and the profits and losses that arise on trading them, show up in the cash flow. If an eye is kept on the cash flow and control kept of the cash, the problems will be found early. Solo consolidation manages to mask everything; it is all one big pot. The tremendous error of judgment made by the regulator of the Bank of England was to allow that informal exemption on a large exposure, on a large inter-group deposit. That was a major error compounded by the fact that it took two years before it was sorted out, which is quite extraordinary.

I feel uncomfortable that Mr. Thompson has been scapegoated, just as the original suggestion that Barings had been brought down by a regular trader is not true. It is the duty of a supervisor in a supervisory regime to work on a team basis; for difficult and awkward decisions to be cast up the line. The noble Lord, Lord Spens, spoke of the plethora of memoranda and minutes. I do not know what the facts are in this case but whatever they are or are not, what should happen is that these issues should be discussed at the highest possible level, otherwise the problems arise that arose in this case.

In summary, the problem for financial institution regulators is to keep pace with rapid changing innovation. Boardrooms do not always understand what is going on and with the aggregation of financial institutions operating in more than one market and operating in different types of product, there is a systemic risk within financial institutions themselves.

The Bank of England is surefooted and experienced in traditional banking. However, it is much less so in the area of securities. It needs to significantly increase its resources. I hope that the Minister will be able to tell us what plans the Treasury has to possibly release the purse strings a little to ensure that the Bank has the best and the brightest in those areas so that it can control and regulate properly. I fear that it does not do that at the moment. It needs to use companies' auditors far more widely and independent auditors. The US has a much harder-edged regime and it is one that I favour. We need less informality and more formality; more strict reporting. We need the concept of fire walls—that is, separation—within institutions. Where the regulator should reside—as a separate organisation or within the Bank—is an important issue and needs to be considered. It is difficult for the Bank to be concerned with the overall stability of the financial system and to take a particularly rigorous line with one institution which may

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upset that. Nevertheless, the real knowledge currently lies within the Bank of England, so whatever we build must be built on that existing base.

There is a need for fundamental change. I was unimpressed with the conclusion that there is no need for a fundamental change. There is need for change. Why? Because there has been a fundamental change in the financial markets, in the way they operate, and the complexity of those markets. There has been a fundamental globalisation of those markets. It is important that the regulatory regime changes in order to deal with it. I should like to see it toughened up and formalised. I should like to see our regulators properly equipped with the necessary resources and skills to deal with complex financial institutions.

As it is the end of term, I should like to finish on a slightly lighter note. On reading the report I discovered that Barings Financial Services was resident at 1 America Square. I recall that that is where a company called J.H. Vavasseur, which was brought low by an earlier banking crisis, was also resident. As it happens, that was the organisation of which, as a result of the lifeboat launch by the Bank of England in 1973, I became chief executive, so it has some memories for me. It is an interesting building. When I went there in 1973 one of the people who worked in the building told me the history of it. Apparently, it had an interesting and colourful history. In the last decade of the last century it thrived as a brothel, providing an excellent service, so rumour has it, to the sea captains of the Port of London. Here we have a site—No. 1 America Square—which has housed two financial collapses but one very successful business so perhaps the City elders, who were the lead regulators at the time the brothel was closed, should re-zone this as a recreational site rather than a site for financial services.

3.5 p.m.

Lord Bruce of Donington: My Lords, the House is most grateful to my noble friend Lord Eatwell for taking this opportunity at the end of term to ventilate further the subject matter of this very interesting and long interim report on the Barings affair. I say "interim" because I share the view of the noble Viscount, Lord Falkland, that there will have to be a full investigation. I sincerely hope that the Government will not use the fact that we are discussing it on this occasion this afternoon as a reason for avoiding either a further investigation or a further debate in this House on the ground, which he might conceivably put forward, that we have already discussed and disposed of it. I do not think that we are going to dispose of this matter for a long time.

For the past 50 years or more I have been a professional practising chartered accountant. My first impulse on reading through the report—I have spent only five hours so far, which barely makes any impact on it—was one of anger. But now it is one of sorrow. I am very sad indeed that such a thing could have happened in the United Kingdom, more particularly after the series of warnings that I together with my colleague Lord Williams of Elvel was able to deliver to

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this House some four or five years ago on the necessity to have some statutory control over these matters as distinct from relying on voluntary disciplines in the financial profession. Noble Lords will recall that at the time the Government decided that they preferred the voluntary approach. I do not think the time is far distant when we may have to consider taking rather stronger action.

Even the provisional conclusions of the report are interesting. I should like to give them to the House so that we may be reminded what the supervisory body itself decided at the end of such investigation as it was able to make. It stated on page 250:


    "Barings' collapse was due to the unauthorised and ultimately catastrophic activities of, it appears, one individual (Leeson) that went undetected as a consequence of a failure of management and other internal controls of the most basic kind".

The words I venture to emphasise to your Lordships are these:


    "as a consequence of a failure of management and other internal controls of the most basic kind".

Noble Lords who have read through paragraph 14.2 of the report will be aware that it specifies these deficiencies. The report states:


    "Management teams have a duty to understand fully the businesses they manage".

Really! They really have to understand the businesses! I would have thought that it was an elementary assumption to make that the controllers should understand the nature of the businesses they are trying to control.

The next requirement is this:


    "Responsibility for each business activity has to be clearly established and communicated".

Hooray for that! I wonder how businesses in this country manage in their generality to continue without that qualification.

The third requirement is:


    "Clear segregation of duties is fundamental to any effective control system".

Tut, tut! We are now treating the real elementum of the whole art and science of management, and it needs to be repeated here.

The report continues:


    "Relevant internal controls, including independent risk management, have to be established for all business activities".

Hooray for that! These are matters of plain, ordinary common sense. One does not need to be an accountant or a management consultant to be aware of that.

Finally:


    "Top management and the Audit Committee have to ensure that significant weaknesses, identified to them by internal audit or otherwise, are resolved quickly".

Well, well, well! These are all respects which this control body finds were absent from Barings. Do noble Lords really know what is being said? It is being said that Barings ought not to have been authorised bankers from the beginning, because any business—I do not care whether it is a whelk stall (one must not insult whelk stall owners in the context of this catastrophe) or what—knows that these are the basic conditions for the continuance of the business. It seems to me that the

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Bank of England ought never to have authorised this concern without verifying that all these conditions were in place.

There are various other sections of the report I could mention, but because it is the end of term and there is the pressure of time through the usual channels, I shall not elaborate on them further. One has to be merciful at this time, particularly as regards government. I hope noble Lords opposite will accept that when we have the next inquiry we shall enter into the matter fully.

Let us consider the position. Out in Singapore we have Baring Futures (Singapore) Pte. It is out there engaged in what are called "derivative transactions". A rose by any other name would smell as sweet. Without in any way detracting from the very desirable activities which should be carried out by banks and others as a hedge against their future position due to possible currency movements, I venture to suggest that the population at large, after reading this report and the press comment on it, will realise that what has really been happening is massive gambling, and plain gambling at that.

Aside from the hedging purpose, which is quite legitimate in these situations, it was a mass gambling racket in betting on the movements of the Nikkei Index. It was pure gambling. No wealth or extra goods were created by it. No extra service was provided. It had no value whatsoever to society. But it had one advantage: it made massive sums—or they thought that it made massive sums—for the proprietors and directors of Barings. They made—or they thought that they had made—billions of pounds over the years. I shall not be so unkind as to read their remuneration to your Lordships because that might cause some discomfiture to the other side of the House where there is a sneaking sympathy for those characters who made vast sums of money.

However, it was their greed that lay at the root of the whole problem. They did not want to know about the internal structure of the firm. Appendix X of the report gives three organisational charts which look very much like a cat's cradle such as we used to make in our childhood days, with criss-crossings of the chart at various points without any controls or relevance whatsoever. So the directors allowed one Mr. Leeson to do something that they should never have allowed. They allowed him not only to originate transactions (whether by computer, telephone or in other ways; the "front-room" activities)—but to handle also the "back-room" activities relating to the settlement of accounts and the tracing of debtors and creditors. The directors allowed Mr. Leeson to have control of both in complete violation of their own rules on the subject, where such rules existed at all. So Mr. Leeson could continue with impunity.

It is not suggested anywhere in the report—not yet, at any rate—that Mr. Leeson diverted any funds for his own personal purposes. It is suggested that he was merely seeking to increase margins and profits for his employers at Barings, including the 50 directors to whom I have already referred. They were very grateful to him. In 1993 the same directors voted Mr. Leeson a £130,000 extra bonus and for 1994 they had it in

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mind—this is on the record—to award him a bonus of £450,000, so satisfied were they with what he had done. The fact of the matter is that if you look at the organisational charts and read through the relevant parts of the report, you will find that there is no form of organised control at all.

There are four aspects to any business, even gambling—and that was done on a massive scale here. There is the business aspect itself—that is, the nature of the business and its expansion prospects. There is the trading function, which deals with the profitability or loss-making of the business. There is the technical aspect, which relates to the personnel, equipment and everything else involved. There is then the financial aspect, which deals with the firm's asset and liability position. No matter how much those aspects are made complicated in massive tomes of business analysis, anybody in responsible business who ignores those four factors, however much they may vary from firm to firm according to the nature of its goods or services, does so at their peril. That is what Barings did. The directors did not investigate Mr. Leeson further because he was delivering the goods. They did not want to do anything to disturb that in any way—even though there had been warning signals, as my noble friend and the noble Viscount mentioned. They simply did not want to know.

Moreover, there is some difficulty in determining how Mr. Leeson became engaged in the first place. It seems to be mentioned in the report—I do not want to cast any aspersions on him whatsoever—that his CV was not examined too carefully to see whether he was suitable to deal with this highly sophisticated form of gambling. Nevertheless, he was engaged, and did well.

I come now to another part which also unfortunately features in the report. Speaking as a professional accountant, I deeply regret it. I am glad that my good friend the late Lord Benson was not alive at the time the report was published because he would have been incandescent with rage at its contents—because we find that there were some auditing defects as well. I regret them. Auditors seem to have got into the position—I make no accusation against particular firms—where they rely excessively on computerised records, and in some cases now install systems of computerised auditing of computerised accounts. That is beginning to be carried to an extreme.

In this case, what happened was—it is clear from the report—that the famous account (Account 8888) that was operated by Mr. Leeson to carry through the bulk of his own transactions was not followed up by the auditors as it should have been. It is the function of an auditor always to verify the extent and the authenticity of those who owe the company money and those to whom the company owes money. It is part of the drill of reputable accountants that they seek by independent communication with debtors to verify that they do owe the money and with the principal creditors to check that the amounts are owing to them. Clearly that was not done in this case. It is greatly to be regretted that that should be the case.

It is all part, of course, of a deeper malaise. I can well recall, as can many of your Lordships who were fortunate to be alive about 25 years ago, that you could

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phone up someone in the City, enter into a contract, not even bother to verify it in writing and be sure that the person's word was his bond. You can no longer do that. Complete trust has gone. It has gone with the new Yuppie-dom, based on the new concept that there is no such thing as society and that it is every man for himself. So that now when you have contracts, not only do you have to have them in writing but you have to have your lawyers pour over the small print to be sure that you are not going to be taken for a ride. That is the state to which British commercial and financial life has now descended.

The irony of it in this case is that it has taken to the field of gambling. It has no relevance to the ordinary people of our country. Millions of people in this country play no part in these vast operations which produce such vast wealth for people. They do not benefit from them. They are irrelevant to them. They have developed into a kind of infernal game which those belonging to approximately the same social bracket and who mix together jest upon and enjoy. Unless they are careful, the edifice will come tumbling down.

My noble friend Lord Eatwell earlier made the observation that in the view of bankers, bankers know best. Perhaps I may respectfully suggest to him, to those in government and to others to whom it may be relevant that it may not be wise, in the light of these experiences and pending further inquiries, to allow our economy to be controlled by independent bankers and those who may have it in mind to have European matters at a macro-level entrusted to so-called independent bankers.

As a result of this, bankers do not have a good name. These particular banks are by no means unique; there are plenty more of them. For the moment, all that we can do is to ensure that these matters are investigated further and that justice is done.

I am not satisfied that all the endeavours have been made to bring Mr. Leeson back here for trial. Two or three days ago I read his wife's letter in the Guardian. She explained that her husband has already pleaded guilty to a specific series of offences under British law. Those seem to have been disregarded. As for the resignation of Mr. Thompson, I regret that too. Although there was a statement on behalf of the bank that it knew nothing about the diversion or swap of funds from the banking to the securities sector, it was also revealed in the press that the securities and futures authority was well aware of it two years ago and that it has been common currency since.

A good deal remains to be investigated. I trust that this House, with its own reputation on the line in these matters, will insist that a further investigation takes place.

3.26 p.m.

Lord Monkswell: My Lords, this is a very important debate on the last day of our "term". We have heard an impressive number of speakers and an impressive number have yet to come. I intend to make only three brief points.

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First, we need to take particular note of paragraph 1.77 of the report. It appears that Mr. Leeson's solicitors have replied to the passing of a copy of the report to Mr. Leeson. They state:


    "We note the preliminary conclusions reached by your enquiry relating to Mr. Leeson. These conclusions are inaccurate in various respects. Indeed, in relation to certain of the matters they betray a fundamental misunderstanding of the actual events".

It is public knowledge that Mr. Leeson has declared that he is happy to give a full account of his understanding of the events, provided that he can do that in this country. The reasons are obvious. I understand that Mr. Leeson is held in a prison in Germany on the basis of an extradition warrant from Singapore. It would be reasonable that instead of residing in a German gaol he should reside in a British gaol under exactly the same terms, effectively awaiting extradition to Singapore. If the Singapore authorities can make a case for extradition, no doubt the British authorities will accede to that. In the meantime, the Government, the Bank of England and the British public can have a full explanation from Mr. Leeson of his understanding and knowledge of these events. That is very important and I hope that the British Government will take urgent steps to ensure that that is brought about.

My second point relates to paragraph 1.72 of the report. It refers to the investigating team's ability to interview all the relevant directors and employees of the Barings group. The team had all the significant documents and so forth but with the exception of certain electronic mail messages, which apparently have not been retained.

Elsewhere in the report we are advised that telephone conversations were recorded. With the prevalence of insider trading, one can understand the significance of that. The telephone is the best way of informing someone outside of the likely means of insider trading benefits. I suggest that the use of electronic mail is the mechanism nowadays by which most formal messages going between parties within firms and between different firms will be recorded, given the vagaries of the postal system.

Personally, I am astounded that those electronic mail messages have not been retained. I have been away from industry now for five or six years but in my experience—and it was only a multi-national engineering company—it was virtually impossible to corrupt, get rid of or even retrieve an electronic mail message. To think that a banking operation would have a system which allowed the corruption or loss of electronic mail messages seems to be utterly inconceivable. That is a major flaw in the whole system. It is a technical detail but it needs urgent investigation.

Finally, bearing in mind that it is the last day of term, we need to pay tribute to the staff who serve us in this House. I know that they will understand the importance of the debate. Some of them—particularly the Hansard writers—will be here for some hours after we have finished. I am sure that they will appreciate the part which they are playing in our effort, on the Floor of the House of Lords, to ensure that not only an individual British citizen receives justice—and we should

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remember that Mr. Leeson should be presumed innocent until proven guilty—but also that the good name of this country is preserved.

3.31 p.m

Lord Haskel: My Lords, unlike many noble Lords speaking in this debate, I have had little experience of the financial services industry, but I have had plenty of experience of the manufacturing industry. That has taught me to recognise danger signals and this report is flashing a danger signal. We should be grateful to my noble friend Lord Eatwell for drawing our attention to it.

As many noble Lords have reminded us, the report blames a rogue trader and a rogue regulator for the collapse of Barings. The analysis tells us that the real culprit is a rogue system. It is the system which is wrong and which needs reform.

The task of reforming Barings now lies with the ING company. That is its task. My concern is with the Bank of England. Broadly, the report tells us that the events leading to the collapse of Barings indicates no need for fundamental change but makes 17 proposals which are designed to make the staff more alert, more knowledgeable and to be more efficient managers.

As other noble Lords have said, that is just tinkering. Does the Minister not understand that the report actually says that securities trading has moved on but the Bank of England has not? The succession of failures tells us that. The danger signals are telling us that a proper shake up is needed, and not just exhortations to do better next time.

The Bank of England is not alone in experiencing those problems, the problems of the modern world, as my noble friend Lord Eatwell called them. Over the past few years, because of tough international competition, many industrial companies have faced the same problems. A successful universal response has been, if your Lordships will excuse the jargon, re-engineering. That is a root and branch appraisal of a business's strengths and weaknesses and a careful analysis of the markets that it is in. Many of our major companies have been re-engineered in order to survive. Perhaps the best example is Rover. British Steel is another good example.

Those noble Lords who read company annual reports will have noticed that many chairmen have recently said that their company is being re-engineered so as better to meet the challenges of the global market and understand and serve its customers better. Is that not exactly what the analysis in the report is calling for? Is not the Bank of England being called upon to organise itself better to meet the challenges of the global market and the needs of its customers? If the Bank of England had been subjected to tough international competition, it would have been re-engineered years ago. But that would have required government action.

Despite the rhetoric, we know that the Government are soft on competition. Indeed, only today in the Financial Times Sir Bryan Carsberg, speaking about his time at the Office of Fair Trading, said that he had never got to the bottom of the Government's failure to be proactive on competition. Not so, my honourable friend

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the shadow Chancellor of the Exchequer, Dr. Gordon Brown who, I happen to know, is a great admirer of the Bank of England.

When speaking to the Labour Finance and Industry Group on 17th May this year about tightening up the Bank of England's monetary policy role, my honourable friend made four proposals: first, a new institutional structure and a monetary policy committee for the Bank; secondly, a new stress on openness and sharing of information; thirdly, new individuals to be added to the Bank's monetary committee; and, fourthly, reform of the Bank's court to oversee monetary policy and accountability of senior executives. This, in order to attract better people.

If those four reforms are needed for monetary policy, they are doubly needed to improve the Bank's supervisory role. Surely those proposals give us a framework for the review called for by my noble friend Lord Eatwell and for the re-engineering called for in the report. Those carrying out such work would look at the internal systems of the Bank—for example, its openness, its accountability, its relationships, whether the best qualified people are being promoted and, most important, whether such reforms can take place within the existing structure of the Bank or whether the supervisory role should be taken on by a new banking commission.

There is another reason for calling for this reform. Until this latest disaster, I was reasonably sympathetic to the idea of an independent Bank of England. However, now I am not so sure. Only a review and a gentle shake-up will restore my confidence in the independence of the Bank. I urge the Minister to listen to those arguments and learn from the experience of those who have re-engineered their companies. If he does not do so, it will not be the Bank of England that is criticised for its lack of alertness, its lack of knowledge and poor management: it will be the Government.

3.38 p.m.

Viscount Chandos: My Lords, perhaps I may begin by making an apology for arriving a little late for the start of today's debate and for the opening remarks of my noble friend Lord Eatwell. I should also declare an interest as a director of an SFA regulated merchant banking firm, a past director of a Bank-of-England-authorised merchant bank; and, indeed, a past director of the International Swaps and Derivatives Association.

I am delighted that the Government have acceded to the pressure that my noble friend Lord Eatwell put upon them to hold the debate today. I hope that the Minister does not feel too isolated in that it seems that every speaker comes from this side of the House. I think that that is quite striking. It makes me think back 13 long years ago to my maiden speech on the arcane subject, as my noble friend Lord Bruce of Donington may remember, of accounting for banks under a European directive. On that occasion, the Benches opposite were crowded with the representatives of merchant banks, arguing that they should continue to be able to disclose the profits that they chose rather than that which normal accounting procedures would require.

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Even though the European directive has been adopted, reading this report there is a temptation to believe that in some merchant banks not much has changed. This report covers a saga of disasters which was a major blow to the UK financial markets as well as a significant direct financial blow to investors in the publicly-traded capital instruments of Barings plc. We should recognise the difference between the depositors who were in the end protected through the acquisition of the bank by ING and the investors in the capital instruments, the preferred shares and the subordinated bonds who have lost the largest part of their investment.

My noble friend Lord Eatwell has powerfully stated the case for fundamental change to the regulatory system in the UK financial markets and banking system. Therefore I shall restrict my comments to one or two points. I myself asked a Question on 23rd March of the Government in relation to the ownership of Barings Bank by a charitable foundation. The Minister who replied for the Government—it was not the Minister who is to reply today—said that, of course, prior to the publication of this report they could make no comment as to the appropriateness of the ownership of a bank by a charitable foundation. I argued—and I continue to believe—that whatever the secondary benefits that accrued from that of generous and substantial grants to charities, it created a structure where there was no accountability at all to outside shareholders. I refer to a charity, the majority of whose trustees were comprised of past and present directors of the bank. I was therefore disappointed to note that in this report there was no attempt by the Board of Banking Supervision to consider this aspect and the effect that it may have had on the culture of the bank and its attitude to risk. The management was not putting its money at risk and it had no outside shareholders to whom it was accountable.

The noble Viscount, Lord Falkland, referred to the "old boy network" and its continued prevalence in the City. If my background might qualify me for membership of that network, my presence on these Benches probably disqualifies me. However, there is truth in the suggestion that the old boy network and the complacency that my noble friend Lord Eatwell referred to are at the heart of this disaster. The report by the Board of Banking Supervision certainly does little to dispel the impression of this complacency. Section 13.58 states,


    "The Bank was told of the intention of Barings' management to apply BB & Co's standards of control to BSL. The Bank regarded the controls in Barings as informal but effective. It had confidence in Barings' senior management, many of whom were longstanding Barings' employees".

I believe that Mr. Al Capone was a long-standing employee of a family business, but I do not think that that was any reason to have particular trust in his competence. We should remember that one member of the Baring family and a past manager of the bank was a governor of the Bank of England. That incestuous relationship that exists between the Bank of England and the institutions it is responsible for regulating cannot ensure that there is rigorous supervision.

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My noble friend Lord Hollick referred to the phrase "one rogue trader" and the impression that the report, and no doubt Barings' management, wishes to give that it was awfully bad luck to suffer this one rogue trader. That is fundamentally wrong. As my noble friend Lord Hollick argued, trading is all about the control of a collection of rogues—of strongly motivated, financially entrepreneurial dealers.

I turn to the question of the solo group and the central part that the concession that was granted to Barings played in the disaster that unfolded. The view that it was a central part is not mine but that of one of the people most intimately involved, Mr. Maclean, of Barings Bank. In section 11.27 of the report he is quoted as saying:


    "I was involved in the setting up of the process which became known as 'solo consolidation', which in my view, is one of the factors at the heart of this problem, this crisis. I think, then, allowing solo consolidation as a technique to be applied, when we look at numbers we see it on the outside of Baring Securities in London but without having controls inside Baring Securities but inside that net, that is the weak link that we will never forgive ourselves for... It could not have happened without solo consolidation. That is the starting point, as far as I am concerned".

In section 11.29 the Board of Banking Supervision disagrees with that analysis. That is extremely hard to understand. As my noble friend Lord Hollick explained, solo consolidation allows the bank to lend to its subsidiaries an amount larger than it is permitted under the large exposure rules to lend to other entities. If those rules had been enforced and the concession that the unfortunate Mr. Thompson had granted to Barings had not been given, then this disaster could not have happened.

What has been learnt from this? In the conclusions, section 13.67 of the report reads:


    "A lack of rigour was also displayed by the Bank in the context of the solo consolidation of BSL ... This was a very significant step—since it would result in BSL ... being included in the unconsolidated returns submitted by BB & Co. ... and in BSL being, in effect, treated as one with BB & Co. for capital adequacy and large exposures purposes. It was also novel, being the first solo consolidation of such a kind which the Bank had experienced".

The words "the Bank had experienced" makes it sound like a nasty bout of flu for which it was not responsible. This was something which the Bank, at whatever level, had specifically permitted.

I should like to ask the Minister, if the report says this was the first occasion of solo consolidation, how many other banks are currently being permitted to treat their securities and other trading activities as part of the solo group and create a structure which, as with Barings, removes a natural check on the excessive trading and speculative activities of such a subsidiary? Why should we not introduce regulation that simply says that there shall be no concessions under the rules of large exposure and the solo group regulations? That would replicate the kind of ring-fencing of securities activities which the US authorities are contemplating as they permit the gradual deregulation of the Glass Steagall Act and the merger of investment banks and commercial banks in the United States.

On Tuesday the Minister argued that the report and the Bingham Report on the BCCI collapse both concluded that there was no case and no need for the

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separation of the regulatory and supervisory role of the Bank of England from its other activities. Even if that were true, individually in each case, surely the Minister and his right honourable colleague, the Chancellor of the Exchequer, must be able to work out that the aggregation of the disasters suggests that something is not working right.

The setting up of the Board of Banking Supervision under the Banking Act 1987 must have been an acknowledgment of the need for an independent overview, but sadly only an overview and a typical feeble compromise of the kind that has created the system and structure that has led to further bank crashes.

Therefore, what is needed is a rigorous and independent body to supervise all financial markets, as my noble friend Lord Eatwell said, as did the chairman of the Securities and Investments Board. I therefore join my noble friend Lord Eatwell in calling not only for a further independent inquiry or at least an independent conclusion and recommendation, but also for the urgent separation of the regulatory and supervisory functions of the Bank of England from its proper role as a central bank.

3.52 p.m.

Lord Desai: My Lords, I join other noble Lords in thanking my noble friend Lord Eatwell for introducing the debate. I particularly thank him for being so quick in drawing our attention to the report because in the normal course of events such reports are published and never discussed. We did not discuss the report on the BCCI and it is only my noble friend's efforts through the normal channels that have given us the debate.

However, I regret that it is the last day of term because something has prevented many noble Lords opposite from being present. We could have used their wisdom, with the many former Chancellors of the Exchequer, people in the City and heads of merchant banks. Unfortunately, all have other engagements. I do not know whether it is the hunting season, the boating season or the racing season. I am innocent as to that culture. But something has happened. Alternatively, they may be on mass strike. We would like to know whether there is an innovation on the other side to go on a mass strike when such a debate arises. But be that as it may, we would have liked the many fountains of wisdom on the other side to have contributed to the debate. Then we would at least have known whether there were any defenders of the Bank of England left in this House.

First, as regards the report, it will not do. I have always held that the Board of Banking Supervision is an inadequate body to have investigated Barings. I said so in the course of a Question which I asked a few weeks ago. The Board of Banking Supervision is not independent. If we look at its composition in the first few paragraphs of the report three people were from the Bank of England. One unfortunately had to resign—for reasons utterly unconnected with financial competence or incompetence, I hasten to add. We are left with the Governor and a person in charge of banking supervision. They were commenting on their own competence or incompetence. Another six people, who were of course

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"independent", were chosen by the Chancellor and the Governor of the Bank of England. I should have liked to see in an appendix to this report the connections of all those independent members. I should like to know where they came from and where they had been. I should like to have known what the interconnections, the old boys' networks, were before I judged the independence of this body. In that respect the report is not very good.

It is also not a very good report because by its own admission (in paragraph 1.78) there were problems of limited access. My noble friend Lord Monkswell has already pointed out that, as stated in paragraph 1.77, there was a failure to elicit a proper response from the lawyers of Mr. Leeson. Therefore, on its own admission, this report is inadequate and incomplete. It failed to examine all the relevant documents. Until we can have a body that looks at all the relevant documents, both here and abroad—and that is important—we cannot be sure that this report is the full story.

As the noble Lord, Lord Spens, pointed out, if it is the practice in the Bank of England that notes go backwards and forwards, perhaps the committee ought to have provided us with some of those documents. When was the 25 per cent. rule agreed to by Mr. Thompson? Who saw the notes? When did the notes criss-cross above and below? Did Mr. Quinn sign such and such a document? Why is Mr. Quinn not willing to resign? I believe that he should have resigned long ago in relation to BCCI; but that is another story. Since he wrote the report, he is clearly not going to resign. So this report is not a very good example of its kind.

Even judging by the standards of this report, there are lots of problems to discuss. It is not just for the sake of independence, but for the sake of completeness and full evidence, that one would like a better report, as again my noble friend Lord Monkswell pointed out. On the grounds of this report, one could not indict Mr. Leeson, since this is not the complete story. One would like to have something far better than this.

What the report does show, however, both in the constitution of the committee and in its authorship, as well as what it brings to light, as many other noble Lords pointed out, is that there is a cultural malaise. There is a culture of connivance, a culture in which people get into such jobs and cover for each other. If my noble friend Lord Hollick had been in his place (I know that he had to leave) I should have told him that perhaps the Bank of England supervised him very thoroughly because he was an estuary boy and had not been to a good public school. Perhaps he should have gone to a good public school; then he would have been part of the old boys' network and would have been let off with a light rap on the wrist and nothing else. That is a problem. Incompetent people get important jobs, and other incompetent people in other important jobs protect them. And none of them ever resigns. Those who resign are the people on the outskirts, those on the periphery who have not been to good schools, people who have been in one or other estuary around the country.

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What will happen—and it is already apparent in the loss of many merchant banks to mainline European banks—is that, slowly and steadily, control of the City of London will be lost from British hands to European hands, because eventually competence tells. Competition and survival of the competent or the fittest will dictate that this kind of culture, in which people are not appointed for their competence but for their school tie, will eventually lose out to cultures that value competence in these matters. That will happen.

It is not only a question of people who are in banking and central banking. As my noble friend Lord Bruce pointed out, it is quite shocking that auditors seem to have behaved in a way that is spectacularly irresponsible. I am surprised that they have not come out with any confession of guilt. According to the newspapers, they took the view that this had nothing to do with them; it had to do with banking supervision and therefore they were not responsible. They should at least pay the money back to somebody or other. I also believe that all the directors should pay their bonuses back. If this had happened to any dole scrounger who had taken a £100 loan from the Government and misused it, he would be hounded. Those who did not pay their poll tax were sent to gaol over a fraction of this money. But here people got away with large bonuses and there were large fees for the auditors. They did an incompetent job but they will not pay back the money. Of course they will not pay it back. That is part of the problem.

The central problem concerns the Bank of England—many noble Lords have spoken about it. I have always held the view that before I can judge whether or not the Bank of England should be independent, I must be satisfied about its competence. Competence comes before independence. I have never understood the high reputation of the Bank of England. Through the years it has failed to be good at monetary policy. Through the ages it has failed to control money supply. That is on record. One can read the noble Lord, Lord Lawson, on that. It cannot control the money supply.

Obviously, it is no good at controlling inflation. One has only to look at what has happened to the present value of the pound. It is not any good at foreign exchange. The pound has depreciated in relation to every other currency in the world, including the dollar. It is not any good at banking supervision. There have not only been the three major failures; as the noble Lord, Lord Spens, pointed out, there have been many other failures which the Bank of England has failed to prevent.

So what is the Bank good at doing? It is good at preserving a facade of a grave reputation. When one hears the name of the Bank of England, one thinks of everything reputable. Perhaps that is as true as the infallibility of the Pope—and we know how true that is. So we know how true is the reputation for competence of the Bank of England.

There is another interesting aspect to this matter. When the crisis first took place, there was a weekend meeting when the Bank of England tried to find a buyer for Barings. Even at that late stage the Bank had not understood the nature of the crisis that Barings was

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undergoing. It took Barings' word for what had happened. But it had independent ways of finding out what had happened. Had it known anything about Barings' management, it would not have spent five minutes trying to find a buyer. Perhaps one should be thankful to Mr. Leeson and his ventures. Through him we found out just how incompetent was the management of Barings. The profits would have been high and the guilty would never have been caught. But it is quite clear that on that weekend the Bank of England did not know the nature of the problem that Barings faced; nor was it aware of the incompetence of Barings' management.

The reactions in the press later were interesting. They not only blamed it on a rogue trader but, because this happened out there in Singapore, it seemed that everything was all right. That betrayed not only a lack of understanding of globalised markets today but there was a kind of snobbishness about the matter. SIMEX and the Singapore authorities have been much more thorough and competent in investigating Mr. Leeson than anybody has been on this side of the affair.

Many noble Lords feel that Mr. Leeson should be brought to this country and tried properly. I hope that the investigation is not conducted by the SFO because that would guarantee his release even before the start. I do not feel that we should compound incompetence with incompetence on this.

On a more serious note, I feel that a case such as this needs to be dealt with by an international court—perhaps the international court. It needs a competency of that scope, which could take together the different jurisdictions in which these events happened. It needs something which can take in jointly both British and Singaporean law and come to a decision. These kinds of problems in which more than one competency is involved will increasingly be on the agenda. We shall have to fashion an international court—perhaps through the G7 or something like that—which can look into situations in which such multiple problems arise. Though this is not suggested in the report, we need to look at the international requirements, not merely co-ordinating the Bank of England with other regulators but also what happens when other regulators fail.

It is quite clear that what we now have in Chapter 14, laid out in very simple terms, is the story that the Bank of England does not know what it is doing. While the report is reluctant to say that it ought to change its ways fundamentally, certainly it needs much more by way of competent staff. It needs a completely different culture if it is going to be competent on supervision.

As one of my noble friends said earlier, it should not be a question of stinting on resources. If regulation is costly, let it be costly, but let it be properly done. If it requires paying a lot of money to people who know the business, let that be done also, but let us have decent, competent regulation. The story of the past 15 years in all the various financial markets in London has been a very sorry story. If that continues, London will lose its prime position as a financial centre. It would now seem that it would not go to Frankfurt, because Frankfurt has

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come here and taken over London. But the City will lose its reputation and a considerable amount of our invisible earnings.

4.6 p.m.

The Minister of State, Department of Social Security (Lord Mackay of Ardbrecknish): My Lords, the noble Lord, Lord Desai, complained that I do not have many of my noble friends present today. Yesterday he and his colleagues were complaining that I had too many. Obviously it is difficult to keep the Opposition happy.

On Tuesday, when I was asked whether we could have a debate and I indicated that the usual channels would discuss it, I did not anticipate that it would arise so quickly. To begin with, I was not too pleased to see my weekend plans unravel in front of my eyes. However, I have found it an interesting and stimulating debate. As somebody who has little knowledge of these difficult matters, and certainly I have never worked in a merchant bank in any shape or form, I found some of the contributions extremely interesting and useful, perhaps one in particular.

We welcome the opportunity to debate this important issue because only by being open—which we are—do we believe that we can restore confidence in the UK financial system. That is why my right honourable friend the Chancellor of the Exchequer decided to publish the report in full at the first available opportunity. I must say to the noble Lords, Lord Desai and Lord Monkswell, that if we had waited until all the pieces of the jigsaw could be brought together before publishing the report, the complaint against the Government would have been that we were involved in a cover-up and not bringing forward the information. That is far from the case. Here we have brought forward the information at the first available opportunity.

There are lessons to be learnt by many parties, most urgently by the regulators of the financial institutions. They will all need to study the report in depth to learn the lessons and put procedures in place to ensure that those lessons are instilled in all the people working in the relevant areas in those organisations. I might add that they should perhaps also read the speech of the noble Lord, Lord Hollick, who apologised to me that he had to leave due to a prior engagement. Speaking for myself, though I suspect for other noble Lords too, I was pleased that he came along and gave us the speech he did; I found it most interesting and significant.

Because many people have to read it and learn lessons from it, the report is important. It is encouraging that the Governor of the Bank of England announced on Tuesday that he accepted the board's recommendations in full and is determined to ensure that they are acted upon. Many noble Lords rehearsed in various degrees of language what the report tells us about Mr. Leeson and about Barings; but the third pillar, if I can call it that, is the position of the regulator. The policy part of this debate introduced by the noble Lord, Lord Eatwell, relates to that issue—whether the supervision of the banks should continue to be carried out by the Bank of England.

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There has been debate both here and elsewhere on that issue. As I said on Tuesday, Lord Justice Bingham included in his report on BCCI that there was nothing in the history of BCCI which argued against the Bank's dual role. The Treasury and Civil Service Select Committee of another place, in its 1993 report into the role of the Bank, said:


    "On balance, we conclude that there is no overwhelming case for separating out the responsibility for prudential supervision to a separate body".

It is certainly possible that a separate body from the central bank can undertake the prudential supervision of banks, as this is done in several other countries. However, even in those countries there is clearly a need for very close co-operation between the supervisors and the lender of last resort. The real issue is therefore whether there is any benefit in the central bank not having this role or if any other organisation could perform it better.

Professor Goodhart, Professor of Banking and Finance at the London School of Economics—he is no doubt known to the noble Lord, Lord Desai—in his evidence to the same committee, put the case for maintaining the status quo rather well when he said:


    "I doubt whether it is really feasible for the central banks to withdraw totally from their supervisory function because they are bound to have a concern with the payment system and ... the operation of the payment system involves the possibility that one or other participant in the payment system might fail. If that was to happen the payment system would grind to a halt and that would certainly make the economy temporarily run into very severe difficulties. In order to prevent that, the central bank has got to be prepared to make loans or to guarantee payments in order to ensure the continuation of the payment system. That puts the central bank in a sense at risk against the possibility of banks involved in the payment system being in an illiquid and possibly insolvent situation and they have to protect themselves against that systemic instability".

Knowing of the passion of the noble Lord, Lord Eatwell, for all things American, and following his suggestion on Tuesday that we might follow the example of the Securities and Exchange Commission, I decided to discuss this point with my advisers. The noble Lord observed that the SEC is not the lender of last resort, but yet the issue of systemic risk does not arise. My understanding is that this is because the SEC is a securities regulator, not a banking regulator. The latter function is principally fulfilled by the Federal Reserve, which is, of course, the lender of last resort. This split of responsibilities is in fact very close to the one we have in the UK and reflects the fact that banks are uniquely prone to systemic risk because their business depends—


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